A significant resurgence of investor enthusiasm toward equities once again greeted the turn of the calendar. Despite new fundamental headwinds associated with the U.S. payroll tax increase, federal budget sequester, and a fresh round of concerns about Europe, the market responded favorably to the removal of domestic tax policy uncertainty, a rebound in U.S. economic activity from depressed levels during the fourth quarter, and additional monetary stimulus from the Federal Reserve.

The economy is indeed off to a better-than-expected start to the new year. Given recent employment gains and positive trends in consumer and business spending, first-quarter real Gross Domestic Product (GDP) appeared to have grown at a healthy clip. Federal fiscal headwinds, however, will present more of a challenge in the period ahead as the Congressional Budget Office (CBO) estimates that fiscal policy will trim real GDP growth this year. Despite the strong start, we think the combination of fiscal policy and a still sluggish global economic environment will likely keep real GDP growth modest for the year as a whole.

Lagging Tech and Consumer PicksSimilar to the first quarter of 2012, which also benefited from central bank intervention, lower-quality stocks—specifically non-earning and low return-on-equity (ROE) companies— materially outperformed. This contributed to the Fund’s relatively poor performance during the quarter, which was primarily isolated to the month of March. From the beginning of the year through February, the portfolio was roughly even with its Russell Midcap Growth Index benchmark before falling behind.

A combination of both stock selection and sector allocation weighed on returns, with holdings in the Technology and Consumer Discretionary sectors among the worst laggards. Tech stocks Juniper Networks and F5 Networks both fell on growing concerns about the health of equipment spending in the communications sector. Two of the portfolio’s largest Consumer Discretionary picks also noticeably lagged the benchmark as that sector significantly advanced. Both LKQ Corp. and PVH Corp. gained more than 40% in 2012, so some consolidation or pullback was natural. We continue to believe the long-term outlook for both companies remains bright. We took advantage of stock weakness in LKQ following a quarterly earnings disappointment to add back to the Fund’s position, having reduced it late last year, as part of our sell and valuation discipline.

Separately, specialty grocer The Fresh Market detracted from performance after announcing weaker than expected results. Even though our favorable view of the firm’s positioning within the industry and long-term growth potential did not change, we decided to exit the position until the drivers of the weakness in company sales become more apparent.

The Fund benefited from an overweight stake in Energy, the top performing sector in the Russell Midcap Growth Index, and a standout performance by construction & engineering service provider Jacobs Engineering Group. Jacobs Engineering benefited from continued backlog growth and growing enthusiasm about a potential boom in petrochemical capital spending. Within Energy, Core Laboratories and Oceaneering International profited from easing global growth fears coupled with solid company-specific fundamentals. We added to the portfolio’s position in Core Labs after the company reported solid results and gave guidance above analyst expectations.

Positioning and OutlookIn addition to eliminating The Fresh Market, we sold the Fund’s positions in Nvidia, SM Energy, McCormick, and Starwood Hotels. McCormick and Starwood both reached our estimate of fair value during the quarter, while Nvidia and SM Energy were eliminated due to lackluster underlying business trends relative to expectations. New positions included semiconductor maker Xilinx and diversified financial services company Raymond James.

After a robust start to the year, the stock market appeared extended and investor sentiment became enthusiastic. As a result, a pullback in share prices would not be a surprise. Underlying conditions for the stock market remain favorable, however, given corporate profits and continued U.S. Federal Reserve accommodation. Any near-term setback would be limited, in our estimation, as the risk of recession is low, inflation is tame, interest rates low, liquidity ample, and valuations are full though not excessive. Longer-term, we continue to expect the overall rate of economic growth to remain subdued, but remain optimistic that the portfolio is well positioned owing to its ownership of superior and attractively priced growth prospects.